With the faster-than-expected OPR hike (+25bps yesterday), we now project another +50bps increase, bringing the benchmark rate to 2.50% by end-2022. While there is risk that KLCI’s earnings yield spread to MGS10 could narrow further (now near mean), we note that the latter is already at a post-GFC high, suggesting rate hike expectations may have been largely baked in. During the 2010 OPR upcycle (+75bps), banks outperformed (KLFIN: +25%) the KLCI (+19%). Likely losers are REITs (narrowed divvy yield spread) and property (higher mortgage repayments). Our KLCI target is unchanged at 1,680.

NEWSBREAK

+25bps OPR hike. Yesterday, BNM raised the OPR by +25bps to 2.00%. While noting that risk to growth still remains, given the improved economic prospects, the MPC has decided to begin reducing the degree of monetary accommodation in a measured and gradual manner.

HLIB’s VIEW

Earlier than expected. Although we recently revised our OPR expectations from a +25bps hike this year to +50bps (see our IPI and Labour reports yesterday), we envisioned it to only materialise in 2H22. With a more hawkish sounding tone, our economics team is now projecting for another +50bps in 2022 (total +75bps), bringing the OPR to 2.50% by year end (refer to our Economics report today).

Altering relative attractiveness vs risk free rate. With expectations for a faster pace of OPR hike, the MGS10 yield (proxy for Malaysia’s risk free rate) may rise further. This would narrow the spread between KLCI’s earnings yield and MGS10 – a measurement on the relative attractiveness of investing in Malaysian equities vs the country’s risk free rate. As it is, the current spread of 2.25% is nearing the 5Y mean (+0.16SD). However, we note that the current MGS10 yield of 4.44% is almost at a post-GFC high, after surging +205bps from its pandemic low in Aug-20 – suggesting that rate hike expectations may have been largely baked in.

Experience from the last OPR upcycle. The last notable OPR upcycle happened in 2010 (coming out of the GFC) where rates were raised by +75bps that year (from 2.00% to 2.75%). Despite the rate upcycle, the KLCI gained +19.3% that year, spearheaded by the index heavyweight banking sector (KLFIN: +25.4%).

Winners and losers. The banking sector (which we are OVERWEIGHT on) is a clear winner from an OPR upcycle as NIM is expected to widen – our banking analyst estimates that every +25bps OPR hike would bump up sector NIM by 5-6bps and earnings forecast by 4-5% (big gainers are Alliance and BIMB, while small gainers are Affin and Public Bank). Sectors on the losing end are likely to be REITs (narrowed spread between divvy yields and MGS10) and property (our property analyst estimates that a 25/50/75bps rate hike would increase monthly mortgage instalments by 3.2%/6.5%/9.9%).

KLCI target at 1,680. While some broad based equity selloff may ensue from this earlier-than-expected tightening, we reckon the KLCI’s downside will be cushioned by gains from the banking sector. We remain constructive on the local bourse underpinned by (i) Malaysia’s relative appeal amid the geopolitical conflict, (ii) sustained transition to endemicity and (iii) possibility of an early GE15 this year, around Aug-Oct. Our KLCI target of 1,680 is based on 16.2x PE (-0.75SD below 5Y mean) tagged to CY22 EPS.

Source: Hong Leong Investment Bank Research - 12 May 2022